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Guggenheim BulletShares® ETFs
An In-Depth Look at
Defined Maturity ETFs
Contents
I.
A Whole New Range of Opportunities for Investors
1
II.
A New Era in Fixed Income Investing
2
III.
Understanding Fund Distributions
4
IV.
Portfolio Applications
6
V.
Defined Maturity ETFs: A Versatile, Innovative Fixed Income Solution
8
This information is intended to be general in nature and should neither be construed as investment advice nor a recommendation of any specific security or strategy.
Published April 2015.
I. A
Whole New Range of Opportunities for Investors
As the ETF market has evolved, so too has the depth and
exposure to a basket of bonds in a single transaction,
breadth of available products.
but unlike mutual funds, ETFs trade on major stock
Defined maturity exchange traded funds (ETFs), a recent
structural innovation in the rapidly growing ETF market,
have created a wide range of new opportunities for fixed
income investors. Today, these ETFs provide sector-
exchanges, affording the added benefits of intra-day
pricing and trading flexibility. They also offer greater
transparency of holdings, potential tax efficiencies, and
generally lower expenses than both mutual funds and
individual bonds.
specific exposure to fixed income markets, including
segments of the market previously only accessible to
For these reasons, fixed income ETFs have become the
institutional investors.
investment vehicle of choice for many investors. While
Investors seeking diversified bond exposure were once
limited to purchasing shares of bond mutual funds or
fixed-income ETFs have been heralded as a convenient,
low-cost alternative to both bond mutual funds and
individual bonds, certain investment strategies such as
purchasing several different individual bonds. While
building a laddered bond portfolio or obtaining targeted
both of these options offer certain benefits, they can
exposure to particular points on the yield curve were still
also present challenges for investors, including limited
trading flexibility and transparency of holdings as well as
potentially higher costs.
only attainable through a direct investment in bonds.
That is, until the introduction of defined maturity ETFs—a
recent structural innovation that has opened the door to
Fixed income ETFs offer a welcome alternative because,
new opportunities for bond investors.
like mutual funds, the ETFs may also offer diversified
Exhibit 1: Asset Growth of U.S. Listed Fixed Income ETFs as of 12.31.2014
■ AUM — # of ETFs
$600
300
200
$300
100
$150
$0
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
# of ETFs
in billions
$450
0
Source: Morningstar.
Guggenheim Investments
Section I: A Whole New Range of Opportunities for Investors
1
II. A
New Era in Fixed Income Investing
Defined maturity ETFs, introduced in early 2010, possess
available in the over-the-counter (OTC) market in which
all of the features of traditional fixed income ETFs with
bonds trade. As such, defined maturity ETFs offer a
one distinct difference: a specified maturity date. Each
compelling combination of diversification and targeted
defined maturity ETF is structured to track an index
bond investing—a potential substitute for individual
comprised of bonds that all mature in a particular year.
bonds and enabling investors to implement strategies
During that year, the index—and the ETF—terminate and
they may not otherwise be able to. Defined maturity ETFs
the ETF’s net assets are distributed to shareholders.
may be a compelling alternative to other fixed income
In other words, defined maturity ETFs have an
products as well.
investment and cash-flow profile similar to bonds while
Following are the key features of defined maturity ETFs,
offering all the advantages inherent in an ETF. Adding to
the benefits they may afford investors, and some factors
their appeal is the fact that they offer a level of liquidity,
to consider when evaluating investment alternatives.
price transparency, and trading flexibility typically not
Pre-Defined
Defined maturity ETFs provide exposure to a particular year of maturity—just as individual bonds
Maturity Date
do—when proceeds1 are distributed to shareholders. Thus, defined maturity ETFs enable investors
to create customized portfolios that address projected cash flow needs and precisely manage
interest rate exposure. By contrast, perpetual-life funds (e.g., mutual funds) offer limited flexibility
to match interest rate exposure and future cash flow needs.
Diversification
Defined maturity ETFs typically offer exposure to a wide variety of individual bonds from multiple
issuers, reducing issuer concentration risk and potentially lowering portfolio volatility. While most
traditional bond funds offer similar exposure, replicating this level of diversification in the OTC
bond market is considerably more difficult and costly, as the minimum investment required to
purchase a single bond is often $10,000.
Exchange
ETFs offer daily holdings disclosure as well as the real-time pricing, intra-day trading, and liquidity
Traded
that come with exchange listing. By contrast, mutual fund shares are priced once daily and
Liquidity and
holdings are usually disclosed quarterly. In addition, defined maturity ETFs generally have tight
Transparency
bid/ask spreads, especially in comparison to those of the OTC bond market—whereas the OTC bond
market can be non-transparent and thinly traded.
1 These ETFs do not seek to return any predetermined amount at maturity, and the amount an investor receives may be worth more or less than their original investment. In
contrast, when an individual bond matures, an investor typically receives the bond’s par (or face) value.
2
Section II: A New Era in Fixed Income Investing
Guggenheim Investments
Lower Costs
Expense ratios for defined maturity ETFs are comparable to other fixed income ETFs and are
generally lower than those of mutual funds. Transaction costs for defined maturity ETFs are
minimized because the bonds in the portfolios are held until maturity (unless called or defaulted).
Additionally, because of the way ETFs are structured and their unique in-kind share creation/
redemption process (which we explore in the next section), the funds generally do not incur the
trading costs associated with cash inflows/outflows from shareholders, as is the case with mutual funds.
Tax Efficiencies
Defined maturity ETFs are generally more tax efficient than bond mutual funds. Mutual funds
often have to sell bonds in order to meet redemptions, particularly in a declining market. And as
bonds in a mutual fund portfolio approach maturity—falling below the fund’s target threshold—
those bonds have to be sold and new bonds purchased. These pressures may increase turnover
in a mutual fund portfolio, creating tax consequences for those who continue to hold shares of
the fund. Defined maturity ETFs, on the other hand, do not sell securities to meet redemptions
and unless the bonds in the fund’s portfolio are called, the securities are generally held until
they mature. As a result, the funds typically generate comparably fewer taxable events. It should
be noted, however, that a defined maturity ETF’s final distribution is considered a sale for tax
purposes and therefore, depending upon the purchase price and holding period, investors may
incur a capital gain or loss.
Monthly Income
Defined maturity ETFs seek to pay a monthly income distribution, as do mutual funds, whereas
bonds pay semiannually. An ETF’s more frequent distributions, if any, may be an attractive feature
for investors looking to supplement their income.
The first fixed income ETFs were introduced in 2002, roughly 10 years after the advent of the ETF
market itself, with the launch of the Standard and Poor’s Depositary Receipt (“SPDR”) ETF. Although
equity ETFs still represent a larger percentage of the total ETF market, fixed income ETFs are rapidly
gaining market share. The total amount of assets in U.S.-listed fixed income ETFs has grown from
approximately $153 billion on December 31, 2008, to more than $543 billion as of December 31, 2014.
Today, there are approximately 221 fixed income ETFs listed in the U.S., offering exposure to virtually
every sector of the market2. The vast majority of these funds are index-based in that they seek to
replicate the performance of a particular benchmark index (before fund fees and expenses).
2 Source: Morningstar, 12.31.2014.
Guggenheim Investments
Section II: A New Era in Fixed Income Investing
3
III. U
nderstanding Fund Distributions
Defined maturity ETFs are designed to provide a yield-to-
ETF are created when an Authorized Participant or “AP”
maturity (YTM) comparable to what an investor would
(typically a large investment firm) delivers to the ETF
realize if they were to invest in the fund’s underlying
a basket of securities representative of the underlying
bond portfolio. It’s important to note that unlike bonds,
portfolio, and the AP receives ETF shares in return. When
which have a fixed coupon payment and return par
redeeming shares, the opposite occurs: the AP delivers
(or face) value at maturity, the defined maturity ETF’s
ETF shares and receives a basket of underlying securities
monthly distributions and final payout may fluctuate.
in return, which are then sold on the open market at
Nonetheless, investors can still determine with a fair
prevailing prices (APs are the only entities that can
amount of accuracy what their YTM may be because
transact directly with the ETF.).
3
these fluctuations occur in opposite directions such
The AP creates and redeems shares as necessary to meet the
that any increase/decrease in income distributions a
supply and demand needs of the marketplace as investors
shareholder may experience is generally offset by a
corresponding decrease/increase in the final payout they
receive at fund maturity. This is due to the way in which
ETFs are structured and the unique share creation and
redemption process.
buy and sell shares on public exchanges, which in turn helps
to keep an ETF’s market price relatively in line with its net
asset value. The creation/redemption process also serves to
minimize transaction costs incurred by the ETF and to reduce
the potential for capital gains transactions that result from cash
The In-Kind Share Creation/Redemption Process
inflows and outflows (For more detailed information on the
ETFs continuously offer and redeem shares through an
ETF share creation/redemption process, see our publication
in-kind share creation/redemption process: Shares of an
Have You Explored ETFs?).
Exhibit 2: Dynamics of Defined Maturity ETF Distribution
Monthly Distributions
Final Payout
Investor’s
Average YTM
3 These ETFs do not seek to return any predetermined amount at maturity, and the amount an investor receives may be worth more or less than
their original investment. In contrast, when an individual bond matures, an investor typically receives the bond’s par (or face) value.
4
Section III: Understanding Fund Distributions
Guggenheim Investments
The Role of Market Interest Rates in Defined
have declined in price, reducing the average price of the
Maturity ETFs
portfolio and therefore, its termination value.
Share creation and redemption, coupled with changing
In other words, the ETF’s distributions and final payout
market interest rates, may cause an ETF’s income
accrual rate to fluctuate because as market rates rise
and fall, the prices and yields of bonds delivered into
and out of the portfolio will change, causing the ETF’s
distributions to fluctuate. For example, if market yields
rise, an AP creating shares of the ETF typically delivers
higher yielding bonds into the portfolio, which serves
to increase the portfolio’s yield and therefore, its
distributions to shareholders. However, because of the
inverse relationship between bond prices and yields, the
higher yielding bonds delivered into the portfolio will
dynamically adjust in accordance with changing market
yields—generally they offset each other such that
an investor’s anticipated YTM will remain relatively
constant.4 The ETF’s distributions will also likely change
as it approaches its termination date: As the ETF nears
its termination and bonds in the portfolio mature,
the proceeds are generally reinvested in cash or cash
equivalent securities earning prevailing short-term rates
until it terminates and the proceeds are distributed to
shareholders.
Exhibit 3: Share Creation in a Rising-Rate Environment
AP delivers higher yielding, lower
priced creation basket of bonds
Average yield of ETF’s portfolio
ETF’s monthly distributions
Average price of ETF’s portfolio
ETF’s termination value
The opposite is true in a falling-rate environment: APs typically deliver lower-yielding/higher priced bonds into
the ETF’s portfolio, reducing the portfolio’s average yield but increasing its termination value.
Exhibit 4: Share Creation in a Falling-Rate Environment
AP delivers lower yielding, higher
priced creation basket of bonds
Average yield of ETF’s portfolio
ETF’s monthly distributions
Average price of ETF’s portfolio
ETF’s termination value
4 These ETFs do not seek to return any predetermined amount at maturity, and the amount an investor receives may be worth more or less than
their original investment. In contrast, when an individual bond matures, an investor typically receives the bond’s par (or face) value.
Guggenheim Investments
Section III: Understanding Fund Distributions
5
IV. P
ortfolio Applications
Defined maturity ETFs can be a powerful tool for
Build and Manage Laddered Portfolios: ETFs can play
implementing a variety of strategies previously only
many roles in an investor’s toolkit—from replacing gaps
afforded through buying individual bonds. ETFs may
created by maturing or called bonds, to managing cash
be particularly attractive for liability-based investing
flow needs, to customizing a portfolio’s duration profile.
because they enable investors to time maturities to meet
But in today’s uncertain market, target defined maturity
anticipated expenses, while also reducing interest rate
ETFs’ most compelling application may be laddering, as
risk as future liabilities approach. Following are some of
ETFs offer new choices to financial advisors and their
the ways in which investors may use the ETFs to create
clients. Laddering with defined maturity ETFs provides a
customized investment solutions.
level of efficiency, cost effectiveness, and flexibility that
Obtain Targeted Yield-Curve Exposure: For investors
seeking to capture perceived opportunities at particular
was largely unavailable through wrappers and individual
bonds.
points on the yield curve, defined maturity ETFs offer
To help manage interest rate risk, fixed income investors
an effective means of obtaining precise, targeted
frequently construct laddered bond portfolios—i.e.,
exposure. Investors can also easily barbell their yield-
portfolios of individual bonds that have varying terms to
curve exposure by simultaneously overweighting and
maturity. As shorter-dated bonds mature, the proceeds
underweighting particular maturity years, while gaining
are rolled over and invested into bonds with longer-dated
an added element of diversification.
maturities. Investing across a range of maturities allows
Manage Future Cash Flow Needs: In addition to
providing supplemental monthly income, defined
maturity ETFs may provide a source of cash that can
be allocated to large future expenses as the ETFs allow
investors to match maturities with expected liabilities.
For example, an investor facing future college expenses
can select ETFs whose terminations align with the years
those expenses will be incurred. As each ETF terminates,
investors to remain in the market—without getting locked
into making a call on the yield curve. There is no need to
make a call on when to sell or redeem, because it happens
automatically in conjunction with the maturity of the
portfolio. And data for annual returns going all the way
back to 1900 show that simple bond ladders focused on
maturities of 10 years or less delivered consistent positive
performance (See Exhibit 5).
the final cash distribution can be applied toward that
year’s tuition payment.
6
Section IV: Portfolio Applications
Guggenheim Investments
Exhibit 5: Bond Ladders: Long-Term History
1900-2014
5-Year Ladder
7-Year Ladder
10-Year Ladder
15-Year Ladder
20-Year Ladder
Average Return
1.5%
4.6%
4.8%
4.9%
5.0%
Minimum Return
0.4%
0.3%
0.2%
-1.5%
-2.1%
Maximum Return
15.5%
15.7%
16.2%
19.3%
21.0%
Source: Crestmont Research.
Yet, creating ladders with individual bonds can present a
as well as for meeting a wide variety of income and
number of challenges, including limited bond availability,
lifestyle needs (e.g., funding college tuition at specific
liquidity and cost constraints, concentrated bond
due dates or reaching a certain retirement date). Defined
exposure, and credit research on individual companies
maturity ETFs also enable investors to create customized
and securities. The availability of individual bonds with
duration strategies adapted to their changing needs.
the investor’s target maturities can be lacking. There may
be liquidity constraints and limited trading flexibility
with individual bonds. Finally, cost can be an issue as
individual bonds may have high minimum purchases of
$10,000 or more.
And over time, laddering gives investors the potential to
benefit from “rolling down the yield curve” and taking
advantage of both income and price changes. This is a
preferred strategy when the yield curve is upward sloping
or steep. An investor purchases a bond at the top of the
Defined maturity ETFs offer a convenient and cost-
steepest part of the yield curve and holds the bond long
effective approach to building laddered portfolios, or
enough until it reaches a lower yielding part of the curve.
filling gaps in an existing laddered portfolio resulting
The objective is to benefit from built-in appreciation that
from matured, called, or defaulted bonds. Laddered ETF
occurs as a normally higher interest rate bond becomes a
portfolios can be used as an inflation protection strategy
valuable shorter-term bond.
Guggenheim Investments
Section IV: Portfolio Applications
7
V. D
efined Maturity ETFs: A Versatile, Innovative
Fixed Income Solution
For fixed income investors, defined maturity ETFs
may apply) and the amount an investor receives at the
offer a range of potential benefits, including flexibility,
time of sale or maturity may be more or less than their
transparency, diversification, and liquidity. More
original investment. If the amount an investor receives
importantly, these innovative vehicles allow investors
as liquidation proceeds upon the ETF’s termination is
and their advisors to implement a range of fixed income
higher or lower than their cost basis, they may incur a
portfolio strategies that until now may have been too
gain or loss for tax purposes. Defined maturity ETFs, like
complex and costly. Whether investors are seeking
any fixed income investment, entail interest rate risk
to generate current income, reduce interest rate risk,
and, depending upon the ETF’s underlying investments,
manage cash flow needs, or meet a range of other
may entail credit risk as well. In addition, because the
objectives, defined maturity fixed income ETFs may offer
distributions generated by the funds are less predictable
a high-quality, low-cost solution—they represent some of
than those generated by bonds, the ETFs may not be
the best and latest thinking in fixed income investing.
appropriate for investors requiring a fixed stream of
As with any ETF, defined maturity ETFs may be sold
prior to their maturity date at the then-current market
price (less any brokerage and transaction fees that
income. Investors should consult with their financial
advisor to help determine whether defined maturity ETFs
are appropriate for their portfolio.
To learn more about defined maturity ETFs and how they may help optimize your
portfolio’s performance, talk with your advisor or visit guggenheiminvestments.com/ETF.
8
Section IV: Defined Maturity ETFs: A Versatile, Innovative Fixed Income Solution
Guggenheim Investments
Risk Considerations: Investors should consider the following risk factors and special considerations associated with investing, which may cause you to lose money, including the entire principal
amount that you invest. Interest Rate Risk: As interest rates rise, the value of fixed income securities held by funds is likely to decrease. Securities with longer durations tend to be more sensitive
to interest rate changes, making them more volatile than securities with shorter durations. Credit/Default Risk: The risk that issuers or guarantors of debt instruments or the counterparty to a
derivatives contract, repurchase agreement, or loan of portfolio securities is unable or unwilling to make timely interest and/or principal payments or otherwise honor its obligations. Debt instruments are subject to varying degrees of credit risk, which may be reflected in credit ratings. Securities issued by the U.S. government have limited credit risk. Credit rating downgrades and defaults
(failure to make interest or principal payment) may potentially reduce the funds’ income and share prices. Asset Class Risk: The bonds in a fund portfolio may underperform the returns of other
bonds or indexes that track other industries, markets, asset classes, or sectors. Call Risk/Prepayment Risk: During periods of falling interest rates, an issuer of a callable bond may exercise its
right to pay principal on an obligation earlier than expected. This may result in the funds having to reinvest proceeds at lower interest rates, resulting in a decline in a fund’s income. Extension
Risk: The risk that an issuer will exercise its right to pay principal on an obligation later than expected. This may happen when there is a rise in interest rates. Under these circumstances, the
value of the obligation will decrease and the funds’ performance may suffer from its inability to invest in higher yielding securities. Income Risk: The risk that falling interest rates will cause a
fund’s income to decline. Liquidity Risk: If a fund invests in illiquid securities or securities that become illiquid, fund returns may be reduced because the fund may be unable to sell the illiquid
securities at an advantageous time or price. Declining Yield Risk: During the final year of the funds’ operations, as the bonds held by the funds mature and the funds’ portfolio transitions to
cash and cash equivalents, the funds’ yield will generally tend to move toward the yield of cash and cash equivalents and thus may be lower than the yields of the bonds previously held by the
funds and/or prevailing yields for bonds in the market. Fluctuation of Yield and Liquidation Amount Risk: The funds, unlike a direct investment in a bond that has a level coupon payment
and a fixed payment at maturity, will make distributions of income that vary over time. Unlike a direct investment in bonds, the breakdown of returns between fund distributions and liquidation
proceeds are not predictable at the time of your investment. For example, at times during the funds’ existence, it may make distributions at a greater (or lesser) rate than the coupon payments
received on the funds’ portfolio, which will result in the funds returning a lesser (or greater) amount on liquidation than would otherwise be the case. The rate of fund distribution payments may
adversely affect the tax characterization of your returns from an investment in the funds relative to a direct investment in corporate bonds. If the amount you receive as liquidation proceeds upon
the funds’ termination is higher or lower than your cost basis, you may experience a gain or loss for tax purposes. High-Yield Securities Risk: Bonds that are rated below investment-grade are
considered to be “junk” securities. While these securities generally offer a higher current yield than that available from higher grade issues, they typically involve greater risk. The ability of issuers
of high-yield securities to make timely payments of interest and principal may be adversely impacted by adverse changes in general economic conditions, changes in the financial condition of
the issuers, and price fluctuations in response to changes in interest rates. High-yield securities are less liquid than investment-grade securities and may be difficult to price or sell, particularly in
times of negative sentiment toward high-yield securities.
As with any investment, you should consider how your investment will be taxed. The tax information contained in the prospectus is provided as general information. Investors should consult their
own tax professional about the tax consequences of an investment as Guggenheim Funds Distributors, LLC does not offer tax advice.
About Guggenheim Investments ETFs
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provider with approximately $29 billion in assets6, Guggenheim Investments seeks to be a go-to
source for strong, actionable ideas to the marketplace. With a history of purposeful innovation,
including many industry “firsts,” Guggenheim Investments delivers what we believe are distinct and
relevant strategies for institutional investors, private wealth advisors, and the clients they serve.
6 Source: ETF.com 1.31.2015.
Consider the investment objectives, risks, charges, and ongoing expenses of any ETF carefully before investing. The prospectus or summary prospectus, if available, contains this and other relevant information. Please read the prospectus carefully before investing. To
obtain a prospectus, visit guggenheiminvestments.com.
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